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C9.4 Economic assessment

Characteristics

Economic assessment consists of a set of decision-making tools intended to select the best and most appropriate projects within the water sector and in comparison with other sectors. It is strongly consistent with IWRM.

There is a basic distinction between cost-effectiveness analysis (CEA) and cost-benefit analysis (CBA). CEA aims to select the cheapest (most cost-effective) method of attaining given objectives, while CBA selects the project with the highest excess of benefits over costs. Economic assessment techniques take account of all costs and benefits on a year-by-year basis over the life of the project or programme, discounting future cash flows at an appropriate rate.

Depending on type, results are expressed as: discounted cost per unit (e.g. of water saved or of treated effluent); Net Present Value (of the surplus of benefits over costs at a specified discount rate); or Internal Rate of Return (discount rate at which benefits and costs are equalised). Financial and economic values are usually differentiated (e.g. taxes and subsidies would be disregarded for economic analysis); a more refined model includes environmental costs and benefits.

Economic assessment can be linked with participatory approaches and demand assessment, and can focus on women’s issues and broader health/livelihood effects of water use. Good economic assessment that reinforces IWRM demands a clear understanding of the direct and indirect impacts of proposed projects. It is a tool that identifies external impacts and equity (ie who pays and who reaps the benefits) as well as efficiency. Economic assessment tools can be highly effective in changing the culture of water managers and increasing public awareness of IWRM. As such they may be termed social change agents (C4).

Lessons learned

When used seriously and consistently, economic assessment can provide an objective way of choosing the best water projects. But it can also be used cynically, e.g. to satisfy external funders, or to window-dress a pre-chosen project.

Other problems include:

• The "technocratic" nature of CBA or CEA, and the use of a single number or single criterion to choose among complex projects
• Technical disagreement among practitioners (eg on which discount rate to use, on defining the "without case scenario", or the inclusion of environmental costs and benefits).
• Its use is not compulsory and its findings are not upheld by any legal requirements (in contrast with environmental impact assessment).

The following are preconditions for the usefulness of economic assessment:

• Politicians and senior administrators are committed to its serious use in selecting public investments
• An suitable guidance manual is available for sector professionals, responsible officials and consultants employed (capacity building B2)
• The policy context is conducive to the selection and successful operation of projects (see A1)
• A range of options exists, sufficiently different to give a real choice (using IWRM), and are compared consistently. Assumptions and the ‘without project scenario’ should be realistic, to avoid casting the project in an artificially favourable light
• Spurious accuracy is avoided; ‘It is better to be approximately right than precisely wrong’.

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